The term Financial Modeling is now common jargon in the Corporate World, especially if you’re looking to build a career in Finance. It tops almost every list for skills that can help open doors, accelerate your career growth or even act as a requisite for entry into the domain! Before we delve into the increasing importance of Financial Modeling, let us understand what exactly Financial Modeling is.
What is Financial Modeling?
As glamourous as the term Financial Modeling sounds, the concept is very simple to understand. FINANCIAL MODELING is the practice of forecasting a company’s financials and performance on a Financial Tool (usually Excel). Financial Modeling can be done for any period of time ranging from a year to 10-20 years. As with any model, Financial Models represent a realistic view of the real world financial situation and are based on certain assumptions made by the Analysts. Financial Models are designed to represent the future performance of a Financial Asset, Business, and Business Division, Project or any other investment.
The purpose of Financial Models is to estimate the value of a business or to compare the business to its peers in the industry. These models are used in strategic decision-making activities and provide a way to test various scenarios, calculate the cost of projects, allocate the corporate resources, indulge in IPOs, fundraising activities, mergers, and acquisitions and many more fields of business!
Why is it gaining so much momentum lately?
Based on your reading, you would have concluded this point that Financial Models have multiple uses. Growing from a niche skill-set, FINANCIAL MODELING has become a requisite skill for almost any Finance Professional to master.
Corporate Finance: Businesses utilize FINANCIAL MODELING to help forecast future performance and growth in order to set targets, allocate corporate resources and plan future strategic activities such as expansion, fund-raising, mergers, acquisitions, and new project proposals.
Investment Banking: Investment Bankers use Financial Models in order to project company performance, arrive at the estimated value of the company and to compare the company to its peers in the industry. This helps them make better pitches when taking the company public, helping it acquire or get acquired, helping clients during mergers and demergers and making lending decisions.
Corporate Banks: Corporate Banks use FINANCIAL MODELING to estimate the future performance of a company in order to make lending decisions such as deciding the terms of the loan, deciding the structure of the loan, making the decision whether or not to provide additional debt to a company and more.
Research Teams: Equity Research Teams use FINANCIAL MODELING to estimate the “Target Prices” for shares of a publicly listed company and to form views on the company’s stock.
Private Equity Firms: Private Equity Firms use FINANCIAL MODELING to assess the risk and return from their investments. It helps them better assess the company’s growth under various circumstances before investing in them.
Credit Rating Agencies: Credit Rating Agencies use FINANCIAL MODELING to form their views on companies, forecast their performance and issue ratings to the company and its debt products.
Mutual Funds: Mutual Funds use FINANCIAL MODELING to better forecast the performance of the individual stocks that they own and the performance of their portfolio as a whole.
Project Finance Companies: Project Finance Companies use FINANCIAL MODELING to forecast financials of companies under various scenarios in order to meet client requirements.
Venture Capital Firms: Venture Capital Firms use FINANCIAL MODELING to assess the risk and return from their investments. It helps them better assess the company’s growth under various circumstances before investing in them.
Analysis: FINANCIAL MODELING is helpful in performing various analyses for a particular company, unit or project including Ratio Analysis, Qualitative Analysis, Sensitivity Analysis, etc.
From the above, we can conclude that the importance of FINANCIAL MODELING roots from its capability to enable better financial and strategic decision-making within organizations. It helps the concerned stakeholders to understand the future growth potential of the company.